Investors who are reluctant in letting their developing economy allocations go may take on a more defensive approach with U.S.-dollar denominated emerging market exchange traded funds.
“We think it’s time to stick to your guns in emerging markets but adopt a more defensive approach,” Sergio Trigo Paz, head of BlackRock’s emerging markets fixed income group, said in a Financial Times article, arguing for hard currency denominated emerging market assets as a way to hedge against currency risk in developing economies. [Not Surprising: Currency Hedging Makes a Difference in Emerging Markets]
“One way to adopt a more defensive strategy is to keep about 60 per cent of your chips in hard currency assets, about 30 per cent in high-quality credit and about 10 per cent in cash,” Trigo Paz said.
Hard currency refers to money issued from a highly industrialized, and politically and economically stable economy, such as the U.S. dollar.
There are a couple of U.S. dollar-denominated emerging market bond ETFs available to investors. For instance, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) and rival PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY) both track U.S. dollar-denominated emerging market debt. [Robust Demand Could Lift EM Bond ETFs]
EMB and PCY will be less affected by depreciating emerging market currencies against the U.S. dollar. For instance, the largest emerging market local currency bond ETF, WisdomTree Emerging Markets Local Debt Fund (NYSEArca: ELD), which is subject to currency risks, has declined 3.7% over the past month, whereas EMB is down 2.7% and PCY is relatively flat.
Emerging market debt ETFs also hold a significant weight toward investment-grade debt. EMB’s credit breakdown includes investment grade AA 3.2%, A 8.1% and BBB 45.6%. PCY includes investment grade AA 4%, A 9% and BBB 48%.
Moreover, emerging debt provide attractive yields. EMB comes with a 5.05% 30-day expense ratio, while PCY offers a 5.17% 30-day SEC yield.
For more information on bonds, visit our bond ETFs category.
Tom Lydon’s clients own shares of EMB.